November 06, 2017

Building a Better Model: Introducing Changes to GDPNow

Among the frequently asked questions on GDPNow's web page is this one:

Is any judgment used to adjust the forecasts? Our answer:

No. Once the GDPNow model begins forecasting GDP growth for a particular quarter, the code will not be adjusted until after the "advance" estimate. If we improve the model over time, we will roll out changes right after the "advance" estimate so that forecasts for the subsequent quarter use a fixed methodology for their entire evolution.

This macroblog post enumerates a number of minor changes to GDPNow that were implemented on October 30, when it began forecasting fourth-quarter real gross domestic product (GDP) growth. Here is a summary of the changes, intended to improve the accuracy of the GDP subcomponent forecasts:

Services personal consumption expenditures (PCE). Use industrial production of electric and gas utilities to nowcast real PCE on electricity and natural gas. Use international trade data on travel services to forecast revisions to related PCE travel data.

Real residential investment. Use employment data for production and nonsupervisory employees of residential remodelers to help forecast real investment in residential improvements.

Real change in private inventories. Use published monthly inventory levels in the U.S. Bureau of Economic Analysis's underlying detail tables 1BU and 1BUC after the third-release GDP estimate from the prior quarter to estimate inventory levels for a number of industries in the first month of the quarter forecasted by GDPNow.

Federal, state, and local government spending. Forecast investment in intellectual property products for these subcomponents using autoregression models.

The first three columns of the following table decompose the official estimate of the third-quarter real GDP growth rate, and forecasts of the growth rate from the discontinued and modified versions of GDPNow, into percentage point contributions from the subcomponents of GDP.

As the table shows, the methodological changes did not have much of an impact on the final third-quarter subcomponent forecasts—apart from inventory investment, where the modifications lowered the contribution to growth from 0.80 percentage points to 0.60 percentage points—or on their accuracy. Nevertheless, the topline GDP forecast of the modified model (2.3 percent) was less accurate than the previous version (2.5 percent). In the discontinued version of GDPNow, an overestimate of the inventory investment contribution to growth partly canceled out underestimated contributions from each of net exports, government spending, and nonresidential fixed investment.

In the modified version, the inventory contribution was also underestimated and did not cancel out these other errors. The last two columns of the table show that all of the subcomponent errors of the modified model were at least as small as their historical average for the discontinued version. However, the topline GDP forecast was less accurate than average because of less cancellation of the subcomponent errors than usual. We hope that the cancellation of subcomponent errors in the modified model will be more similar to the historical average in the discontinued version in the future.

Although the methodological changes could have more of an impact than the table suggests, we do not expect them to have a substantial impact in general. For example, on October 30, the discontinued version of GDPNow projected 3.0 percent GDP growth in the fourth quarter, which was little different from the modified model forecast of 2.9 percent growth. We provide a more detailed explanation of the changes to GDPNow here. Going forward, this same document will document any further changes to the model and when we made them.

By Pat Higgins, a policy adviser in the Atlanta Fed's research department

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